It's Just a Stock

When I posted Friday that I was taking exit signals for our positions in AAPL I was quickly asked by friends and followers why I would sell Apple's stock. My response surprised them. I said AAPL is just like any other stock. Sometimes stocks go up and sometimes they go down. I don't control this and neither do you. What I do control though is what I'm willing to risk.

Apple finished at a new 25-week closing low.

These responses prompted me to write this up for study. AAPL's stock has created a unique style of investor in that those that follow believe 100% in the products, and those products have a large role in their daily lives. And that's fine, I love my iphone 6+, its a fun and functional device to have. But I also understand the supply/demand balance that exists in the stock market.

Being that I am a relative strength investor I prefer to move in and out of positions as the dynamics shift in the supply and demand for a stock. I don't try to guess which way a stock is going to move, I simply position myself with the current trend and listen to what the market is telling me.

So many individual investors struggle with the concept of trading what is in front of them and prefer to trade what they expect to happen based on some narrative they have. Most believe so deeply in a story that they fail to acknowledge that risks continuously change within their investments.

Retail investors fear selling "their" stocks. But why do people feel such angst towards exiting a position? The answer realistically is too deep to understand completely in a blog post, but the main reasons are rooted in the "fear of missing out" and being unable to "time the market".

The Fear of Missing Out

The idea that many have is if they are not fully invested in a stock at all times they might miss a gigantic move to the upside. While this can happen, the price you pay to not miss out can often be detrimental to your wealth. People think they cannot time the market to buy when a stock is in a strong position and cannot time their sale when something is amiss with the stock. They basically give in and say "I'll take the bad with the good and just hold on for the long-term". That can be a fine strategy IF you can handle losing 50% or more of your money and not make an emotional decision. Most cannot and they panic at the worst time, selling into the lows and failing to get back in if the stock reverses.

The Fear of Missing Out effects us all in some way or another. Nobody wants to see a stock they like rocket higher without them. It sucks, I've been there. But I also believe in the power of negative compounding, where taking substantial losses requires exponential future returns to make up that loss.

Chart provided by: mwdeferred.com

Selling is Not the End

The other primary reason people don't wish to sell an investment is simply because they feel emotionally attached and selling would thereby be admitting defeat. We don't like to be wrong, we also don't like missing out on what could be more upside to come (see above). Many it seem feel selling a stock is a final decision; selling in effect terminates the contract you had with the company. But there is no rule that says once you sell a stock that you can't buy it back later. Yet many continue to fear selling until the moment when their fear of loss overpowers their greed.

The majority of investing is psychological and selling tends to trigger the most emotional responses. It doesn't have to be that way though. There are proven ways to execute successful timing of investments. Sure the strategies are not 100% accurate, but the concept of keeping losing trades small and letting winning trades grow large has withstood the test of time.

Trend trading is among the simplest methods of managing risk and one of the oldest successful investing strategies. We own stocks that are continually making a series of higher highs and higher lows (uptrend) and avoid or short stocks that are making lower lows and lower highs. Spotting the change is not difficult when you implement the basic strategy to its core principles. However most struggle to implement the strategy psychologically due to their preconceived biases surrounding the stock.

Here is the previous decline in Apple's stock in 2012:

Peak to trough AAPL's stock fell nearly 50% from September 2012 to June 2013. Basic trend analysis identified the prior rally from August 2011 until the trend broke in November of 2012. Using trend alone caught a 100% rally and avoided the last 30% of the 50% correction. It then alerted again in August of 2013 that a new uptrend may be taking shape.

That breakout and higher high in August set the stage for another 100% rally and just this Friday set the first lower high/lower low in two years.

This may not be the end of the rally or it may lead to a 50% correction again, we simply do not know. What we do know is the trend of higher highs and higher lows has now been broken. This elevates risk and is the signal I watch for to move to the sidelines.

This is where the trouble comes in for most retail investors. I was asked by a friend after posting my exit Friday, "well what happens if it turns around and goes back up?". I said I would get back in. He then asked "how do you know when to get back in once you sell?". I told him the same thing I posted above. When a new trend of higher highs and higher lows develops I will take the new trend signal.

Once you have a methodology that you trust it takes all the guessing out of the market. There are no more emotional reactions, you simply execute the strategy and stick to your rules. A stock is just a stock. When you make it more than that it becomes an emotional connection and makes impartial judgement difficult.